Valuation - Long Term Contracts
The basis of valuation should be cost plus attributable profit as benefits less foreseeable losses and progress payments both receivable and received. It becomes essential to verify the suitable amount of profit such can be taken on a contract. This suitable attributable profit or benefit is arrived as follows:
Total costs to Date x Anticipated total profit x Allowance = Attributable for prudence profit
This formula derives the net profit such can be considered on the contract to date. This profit than it had been worked out must be reduced through any profits occupied in previous years to find out the attributable profit for the year. Such for the auditor, the following points must be notice:
1) Total costs are derived from the recent estimated net costs for the contract
2) Total profits is derived from the contract price less whole estimated costs
3) Prudence must be taken into account whenever determining the amount of attributable profits. Through prudence in this case we signify you must contain into account the likelihood of the profit figure to be realized and this is a function of
a) Time: which is the longer a contract has to run the quite complicated it is to determine the profit.
b) Consider the company's capability to estimate its costs exactly.
c) Consider the behaviour of the contract: a fixed price contract is far more dangerous than one that permits costs escalation: hence a cost plus contract carries very little danger at all.